The Recovery's Virtuous Circle Means More Growth Ahead

The economy is going to keep growing. A recent survey shows that many economists expect to see a 4% rise in consumer spending in the first quarter of 2010, twice the previous estimate. Not only is that good news for working people, it's good for people who own stock -- and for incumbent politicians.

As the good news for the U.S. economy keeps coming -- for example, new home sales were up 27% in March -- the fear clenching American consumers' wallets shut may be weakening. Retail sales rose 9.1% in March and in the first two months of 2010, exports climbed 15%.
A Virtuous Circle

In an article about the emerging recovery, The New York Times interviewed consumers who are getting more comfortable about spending. For instance, Dan Schrenk, an information technology consultant, told the Times that after cutting back on dinners and purchases in 2009, he had picked up five new clients in 2010 and was feeling wealthier due to the rising stock market. Poised to buy an iPad at a Best Buy (BBY) in Beaverton, Oregon, he said, "I'm certainly interested in spending now that the stock market seems so relaxed."

On Monday morning I participated in a radio interview in which the host mentioned that many of his friends are telling him their 401(k)s are looking much better these days. And why not? Since its March 2009 low, the S&P 500 is up 79% to 1,217 (though still 22% below its October 2007 all-time high of 1,562).

What is going on here? A virtuous circle is under way, and that's the key to getting the economy moving. In a virtuous circle, people get more money and they spend it. Since consumer spending accounts for 70% of GDP growth, the spending boosts demand and the increased demand drives factories to produce more to meet that demand. When those factories can't produce enough with their existing employees, they hire more, which means there are more people with more money to spend.

While many thought it would take more jobs to get such a virtuous circle going, rising stocks may have done the trick, aided by the $787 billion stimulus plan. A higher stock market makes people feel richer and gets them spending more. And since consumers have cut debt by $600 billion and still have $2.964 trillion in money market funds, the powder for a two-fisted recovery, based on a rising wealth effect due to rising stocks and new jobs, remains dry.
Political Winners Too?

The emerging recovery will not just help American consumers, it could benefit political incumbents in November. How so? One word: trust.

As the economy suffered from the vicious circle of the credit crisis, declining output, rising unemployment and a falling stock market, distrust in the American system grew enormously. And this distrust is one of the main emotions that fuels the folks who hit the streets carrying signs about how much they hate government, which is bad news for anyone currently holding office.

As the virtuous circle builds, the economy will keep getting better. This will lead more people to feel less fearful and have increased faith in the system. The resulting rise in feelings of trust should make people feel more trust in government. And that greater contentment could take the wind out of the sails of America's anti-incumbent mood.